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Are Compensation Cuts The Trend Of The Future?

News reports out of the United States this week indicated that auto parts maker Delphi Corp. has reached a tentative deal, with the United Auto Workers, involving substantial pay cuts for employees. I’m here to say that we should all get accustomed to headlines of this type because they aren’t likely to end with Delphi.

Delphi is the former parts arm of General Motors Corp. which was spun off into a separate company in 1999. General Motors is still its biggest customer, but Delphi supplies other car manufacturers as well.

Delphi, crippled by labour costs, filed for bankruptcy protection in 2005 and requested court permission to void existing labour contracts. The company has spent a couple of years working to emerge from bankruptcy protection, and a deal to cut wages was characterized by Delphi as a “significant milestone” in that quest.

Delphi reportedly lost $533 million in the first quarter of 2007 after having lost $5.5 billion in 2006. The tentative deal with the UAW would see employee wages cut from around $27 per hour to a range of roughly $14 to $18 per hour.

Delphi, of course, is not the only company in the domestic car business which is having trouble. Its former parent, General Motors, is an example of what’s wrong with the “big 3” domestic automakers.

According to published reports, GM is saddled with $1,600 per vehicle in so-called legacy costs. These are the health and pension benefits costs for the company’s retirees. That $1,600 increases the price tag of every vehicle GM sells, adding to its difficulties in retaining its traditional market share.

In 2006, GM announced substantial changes to the structure of these benefits for existing employees, but the legacy cost burden isn’t one that will disappear overnight. It has been building since the company began picking up the tab for its employees’ medical insurance, pensions, and retiree benefits in the 1950s.

In 2005, the Washington Post estimated that GM was carrying a $54 billion shortfall for these pension and health care benefits. The same publication estimated that, in 2005 alone, GM paid $5.6 billion in health care costs for the 1.1 million present and former employees covered by the plan.

The reality is that, as the cost of medical and pension benefits escalate, more and more companies will be forced to reduce and restructure those costs in order to stay competitive. It’s simple mathematics - when the price of products or services is affected to such a significant degree by such add-on compensation items, companies have no choice but to alter their employee compensation structure.

This trend of increasing costs points to a likely reduction in the value of employee compensation packages. But this happens to be occurring at a time when employee compensation is being pushed in the opposite direction by the impact of the so-called labour shortage.

Predictions are that the availability of labour is going to continue to fall as the bulge of the baby boomers leaves the job market. According to simple supply and demand theory, that should drive the cost of labour up. It makes sense that one way employers would be trying to attract scarce workers would be through enhanced benefits packages.

Eventually, however, if the size of the workforce is shrinking then so will the size of the market in which they operate. There simply won’t be as many people out there to purchase cars, homes, and washing machines. The same logic applies to the service industry. With fewer people out there to serve, there will be an inevitable shrinkage in the number of companies or in the range and volume of products they can sell.

My own best guess is that the trend of spiraling salaries and benefits (due to the labour shortage) will be a temporary phenomenon. That could mean several decades but, eventually, a balancing of supply and demand will mean that the economy won’t be searching for more workers than are available.

What won’t change is the crippling impact on the bottom line of medical and pension benefits. If anything, those items are likely to become more expensive as time marches on. If that’s the case, we can all look forward to a future in which we fondly remember the good old days when our employer supplied things like pension contributions and medical benefits.